Abstract

We study the effects of technological progress in upstream agri-food markets on vertical differentiation in a downstream duopoly. The duopolists, who enjoy seller and buyer market power, transform homogeneous agricultural input into goods of varying qualities. We find that a cost-reducing innovation increases differentiation, and this differentiation comes from a sizable decrease in quality of the low-quality firm. The intensification of differentiation results in a market-expansion effect that largely benefits consumers. The distribution of benefits between upstream and downstream industries are consistent with the observation of a decreasing trend in farmers’ share of the retail food dollar.

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